Strong Dinar And Moderate Inflationary Pressures To Drive Further Monetary Easing In Serbia

At Fitch Solutions, we expect inflation in Serbia to accelerate from 2.0% in 2019 to 2.5% in 2020 and 2.6% in 2021, thus remaining below the National Bank of Serbia (NBS)’s target midpoint of 3.0%.

Against the backdrop of moderate domestic inflationary pressures and a strengthening Serbian dinar, the NBS will likely loosen monetary policy further in a bid to support the Serbian government’s economic growth targets.

Monetary easing in Serbia will also be made possible by the global dovish shift in monetary policy. We see the NBS cutting its main policy rate once in 2020, from the current level of 2.25% to 2.0%, while maintaining rates on hold in 2021.

We at Fitch Solutions maintain that headline inflation in Serbia will accelerate from a forecast of 2.0% in 2019 to 2.5% in 2020 and 2.6% in 2021. In line with our view, inflation remained subdued in Q219, averaging 1.2% year-on-year (y-o-y). Inflation rebounded to 1.5% y-o-y in November, taking the year-to-date average close to our 2019 forecast at 1.9%. We expect inflation to continue gathering momentum over the coming quarters, as robust aggregate demand amid high capacity constraints puts upward pressure on prices. Both growth in household demand and gross fixed capital formation will likely accelerate in 2020, spurred by looser fiscal and monetary policies as well as higher wages and strong corporate profits (see 'Lower Financing Costs To Boost Investment In Serbia' 30 December). This increase in demand will likely remain unmatched by an increase in supply, with capacity utlilisation set to remain at historic highs in 2020 amid an acceleration in economic growth (see chart below).

That said, we expect price growth to remain below the National Bank of Serbia (NBS)'s target midpoint of 3.0%, as a stronger Serbian dinar will dampen imported inflation. We see the Serbian dinar appreciating to an average RSD117.17/EUR in 2020, from an average RSD117.77/EUR in 2019, as foreign demand for Serbian assets remains strong. The Serbian dinar saw some appreciation throughout 2019 on the back of increasing foreign appetite for Serbian assets, namely stronger foreign demand for Serbian government debt. We expect the Serbian dinar to appreciate further over the coming quarters, as strong economic growth will continue to underpin robust investor confidence and attract further foreign direct investment. Meanwhile, foreign demand for Serbian government securities will likely increase in 2020 and boost portfolio inflows into Serbia (see 'Strong Economic Growth In Serbia To Boost FDI Inflows' 04 January). From a forecast fiscal deficit of 0.1% of GDP in 2019, we expect the budget deficit to widen to 0.5% in 2020. We also note that NBS interventions in the foreign exchange (FX) market are unlikely to offset the appreciation of the Serbian dinar in 2020. The NBS significantly increased interventions in the FX market between Q219 and Q419 (see chart below) and will continue with FX interventions in 2020 in an effort to contain short-term volatility of the exchange rate.

With price stability in check and a strengthening dinar supporting the relative attractiveness of Serbian assets, the NBS will focus on helping the Serbian government reaching its economic growth targets. The NBS cut its key policy rate from 2.5% to 2.25% in November, in line with our view (see 'Further Monetary Stimulus Likely To Come In Serbia' 02 October). The cut, which followed two 25 basis points (bps) cuts in July and August, aimed to stimulate economic activity following relatively weak GDP data releases in Q119 and Q219 (2.6% and 2.9% y-o-y respectively). While GDP growth rebounded to 4.8% y-o-y in Q319, the government's ambitious economic growth targets for the coming years imply the need for additional monetary easing. The Serbian government projects GDP growth of 4.0% in 2020, from an expected 3.5% in 2019, and announced its intention to support an acceleration in annual growth rates to 7.0% in the coming fiver years through infrastructure spending.

The general dovish turn across major central banks will be an additional factor allowing the NBS to ease its monetary policy without compromising the attractiveness of Serbian assets to foreign investors. We forecast monetary policy in the eurozone to remain accommodative throughout 2020 amid below-target inflation, with further monetary stimulus being delivered through additional cuts to the deposit rate. The US Federal Open Market Committee (FOMC) will likely keep its rate on hold throughout 2020 after a cumulative 75 bps in 2019, with risks tilted to further cuts in case of a sharper-than-expected slowdown in growth. Monetary policy is also set to remain loose in Serbia's regional peers, namely in the South Eastern European region. Monetary policy in Bulgaria and Croatia will mirror the actions of the ECB, as the Bulgarian lev is pegged to the euro and the Croatian Kuna is in a tightly-managed crawling peg to the euro. The National Bank of Romania (NB) will likely keep interest rates constant until the end of 2020. The dovish stance of these central banks will ensure that the Serbian economy remains relatively insulated from significant swings in international capital flows, supporting monetary easing from the NBS. All considered, we expect the NBS to cut its key policy rate from 2.25% to 2.0% in 2020 and to maintain rates on hold in 2021.